Has GameStop Caught Lightning in a Bottle?

by Anthony John Agnello | November 18, 2011 1:52 pm

Has GameStop Caught Lightning in a Bottle?

The video game business lives and dies by the holiday season. In October, when Nintendo (PINK:NTDOY[1]) reported a $258 million third-quarter loss[2], it was no big surprise. That company and many others in the industry are accustomed to taking a hit during the summer months when consumers spend more on activities than indoor entertainment. The fourth quarter, when big games release and retailers run big Black Friday-style sales, are when the profits roll in.

What was unusual about the aforementioned earnings was that Nintendo cut its forecast for the full year, lowering its expectations to a loss of around $264 million[3] — what would be the company’s first annual loss. For game-makers like Nintendo whose chief business is the sale of physical goods at retail, these days of increased digital sales are making for trying times. So imagine how video game retailers like GameStop (NYSE:GME[4]) are faring.

Actually, don’t bother imagining. GameStop announced Thursday that, going into the holiday season, sales are not matching expectations[5]. New game sales for the quarter ending Oct. 29 grew just 4.8%, and total sales grew 2.5% to just under $2 billion. Profits dipped to under $54 million, a year-on-year fall of about 1.5%.

All of this crummy news led GameStop, which decreased its full-year forecast in August to 4.5% to 6.5% revenue growth, to lower guidance again Thursday — this time to 2% to 3% growth on expectations of flat to slightly lower same-store sales. CEO Paul Raines told The Wall Street Journal that he believes GameStop’s disappointing sales are due to “uncertain” consumers. The news sent GME shares down about 2.5% Thursday, though they since had regained their ground by midday Friday.

However, there is a silver lining to GameStop’s earnings report. As in the August quarter, GameStop is continuing to see positive growth in sales of digital goods and services. In particular, the company sold 600,000 subscriptions to Activision Blizzard‘s (NASDAQ:ATVI[6]) Call of Duty Elite service. Call of Duty Elite is a $50-per-year premium service offered by Activision Blizzard that gives players of the company’s hit series Call of Duty access to digital add-on content[7], as well as stat-tracking services for players. Think of it as the video game equivalent of ESPN’s fantasy sports services.

That a retailer like GameStop was able to rack up approximately $30 million in sales of a purely digital service — which consumers just as easily could have bought directly from Activison Blizzard online — is promising for a company that is contending with an increasingly digital market. Sales of Elite were of course bolstered by sales of ATVI’s latest game, Call of Duty: Modern Warfare 3, which itself racked up $775 million in its first five days[8] on shelves this month. Of course, these Elite sales aren’t all gravy — they’ll go toward offsetting declines in its other subscription-based juggernaut[9], World of Warcraft.

These sales would seem to indicate that GameStop can use digital goods sold in tandem with hit releases to offset declines in disc-based sales. However, the Call of Duty franchise is a cultural phenomenon at this point. Where Modern Warfare 3 sold 6.5 million copies in 24 hours, most games struggle to sell 1 million copies within a year of release. Simply put, GameStop can’t expect to make up for revenue losses with similar services on any sort of consistent basis.

Still, the retailer’s overall digital operations are showing impressive growth. Total digital sales grew 69% year-over-year[10] in the August quarter, with sales totaling $98 million. Those sales accounted for 42% of GameStop’s profits during the period. Even if services like Call of Duty Elite can’t be replicated, they can act as supplements to the company’s growing digital concerns. GME shareholders simply need to hope those digital sales grow fast enough before falling physical media sales kill the company.

As of this writing, Anthony John Agnello did not hold a position in any of the aforementioned stocks. Follow him on Twitter at @ajohnagnello[11] and become a fan of InvestorPlace on Facebook[12].